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ACCA Applied Skills · Financial Management · Investment appraisal techniques

When using the equivalent annual cost method to choose between two replacement cycles for an asset, which of the following is the decision rule?

Choose the replacement cycle with the lowest equivalent annual cost. The EAC turns the present value of costs for each cycle into an equal annual amount, which makes cycles of different lengths comparable, and as the figures are costs, the smallest annual cost is the best option.

  1. AChoose the cycle with the highest equivalent annual cost
  2. BChoose the cycle with the lowest equivalent annual costCorrect
  3. CChoose the cycle with the shortest replacement period
  4. DChoose the cycle with the lowest total undiscounted cost

Explanation

The EAC converts the present value of costs over each cycle into an annual equivalent cost, allowing comparison of different lives. Since these are costs, the lowest EAC is preferred. The highest EAC would be the most expensive.

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